1 Will the profit from the sale of your properties situated at XXXXX be included in your assessable income under section 6-10 of the Income Tax Assessment Act 199 7 (ITAA 1997) on the basis the profit will be from a mere realisation of a capital asset transaction?
1 Yes. This ruling applies for the following periods: Year ended 30 June 20YY Year ending 30 June 20YY The scheme commenced on: 1 July 20YY
The Property You purchased the property on DD/MM/20YY for $XX. Your spouse is not currently registered for an Australian Business Number (ABN) or Goods and Services Tax (GST). You and your spouse purchased the property funded by X bank loans. The purpose of the loans was listed in the loan offer as 'other' and 'predominantly investment purposes other than residential property purpose'. You did not pay any GST on the purchase of the property. The property is situated on XXXsqm of land. On DD/MM/20YY, immediately after settlement you rented the property as an investment rental property until DD/MM/20YY. On DD/MM/20YY, you and your spouse received a development report from the development firm to access the feasibility of subdividing the land and constructing X town houses with the goal of transitioning from the negatively geared investment to a neutral or positively geared investment. On DD/MM/20YY, a rental report estimated rental returns of $XXXXX annually. On DD/MM/20YY, you were advised in the loan strategy that the cost of the interest-only expense would be $XXXX per month for the first X years.
On DD/MM/20YY, you confirmed with the project manager your intention to hold X properties as long term rental properties and was advised that no GST credits would be claimed. You have no experience in subdividing or the development of property. You obtained assistance to survey the land from a developer, who prepared the developmental approval application. The development application approval was received. On DD/MM/20YY, you signed the building contracts with the developer for $XXXXX (Including GST) for each unit, a total of $XXXXXX. On DD/MM/20YY, you and your spouse refinanced one of the original loans with the bank. The purpose of your loan was listed as predominantly investment purpose. On DD/MM/20YY, you signed the building contracts with the development firm for $XXXXX (Including GST) for each unit, a total of $XXXXXX. On DD/MM/20YY, the development firm increased the building price by $XXXXX for each unit, a total of $XXXXX. There was an increase in build area from XXX sqm to XXXX sqm as per the provided variation certificate. On DD/MM/20YY, the first loan strategy update was done on the basis that the X townhouses would be retained.
On DD/MM/20YY, you received a demolition certificate from the City Authority with the consent to demolish the dwelling. On DD/MM/20YY, you engaged a builder to demolish the existing dwelling to subdivide the land. On DD/MM/20YY, there was a second update of the loan strategy based on the intention to hold X properties. You intended to retain all X townhouses as long-term rental properties. On DD/MM/20YY, the development firm increased the building price by $XX for each unit, a total of $XX as outlined on the variation certificate. On DD/MM/20YY, the certificates of title were issued - XA, XB and XC XXX following the completion of the subdivision. On the subdivision, the size of the land was split for each property, each with its own title and X town houses were built on the property. On DD/MM/20YY, you signed the loan contracts for the construction of the X townhouses. This was based on the renegotiated loans due to the increase in the building costs. This resulted in the reduction of the interest only period to X years at the interest rate of XXX%. On DD/MM/20YY, the building permits were received from the City A Authority.
You did not register for GST in relation to the construction of the townhouses and did not claim any GST credits. On DD/MM/20YY, the certificate of site possession was issued to the builder. On DD/MM/20YY, you took out Interest only residential investment home loans with the bank in relation to the construction of each townhouse. You initially took out these loans on an interest only repayment basis. On DD/MM/20YY, an updated feasibility report by the project manager with projected net position per month to be $XXXX when retaining all X properties. On DD/MM/20YY, the annual review with financial advisor confirming that the investment would be cost neutral once tenanted. From DD/MM/20YY to DD/MM/20YY, your spouse was unable to work due to health issues. On DD/MM/20YY, you entered into property management agreements to rent the X townhouses. On DD/MM/20YY, a review of the loans done by a new broker regarding the refinance following the completion of the building and to extend the interest-only period. On DD/MM/20YY, the construction of the X townhouses was completed and you immediately commenced securing the tenants.
On DD/MM/20YY, you secured tenants to be rented at $XXX per week each resulting in a cash shortfall of $XXXX per month to service the loans. On DD/MM/20YY, you went back to work after the health issues. On DD/MM/20YY, your spouse resigned from their job due to the demands of work travel and the impacts on their health. On DD/MM/20YY, your spouse started another job with a much lower income than the previous role. On DD/MM/20YY, the rental income increased to $XXX each for the X town houses. On DD/MM/20YY, is the expiry date of the interest only loan and the principal and interest repayments with the interest rate of XXX% started. You could not refinance due to changes in your income. On DD/MM/20YY, the interest rate on the bank loan was reduced to XXXX%. On DD/MM/20YY, the tenant in townhouse X vacated breaking the lease due to loud noise complaints from the neighbour were suggested not to renew lease that was expiring in MM/20YY after inspection of the property. On DD/MM/20YY, a new 12-month lease for townhouse XX at $XXX per week was started. The real estate documents are also provided. Currently, the loan repayments exceed the rental income by an estimated $XXXX per month.
You intended to sell townhouse X after the lease expired in MM/20YY and YYY after the lease expires in MM/ 20YY. Townhouse XX was sold with a contract date of DD/MM/20YY. You have requested an appraisal from qualified appraiser after informing them of your intention of selling the townhouse YYY. You will hold the third townhouse and continue to rent it out. You are not a property developer and have not conducted similar transactions previously, either personally or through another entity.
Income Tax Assessment Act 1997 section 6-5 Income Tax Assessment Act 1997 section 6-10 Income Tax Assessment Act 1997 section 15-15 Income Tax Assessment Act 1997 section 104-10 Income Tax Assessment Act 1997 subsection 104-10(5) Income Tax Assessment Act 1997 section 118-20
Under section 6-5 of the ITAA 1997, your assessable income includes the ordinary income you derived directly or indirectly from all sources, during the income year. Although the legislation does not define income according to ordinary concepts, a substantial body of case law has evolved to identify various factors that indicate the nature of ordinary income. Section 6-10 of the ITAA 1997 states your assessable income also includes some amounts that are not ordinary income, which is assessable as statutory income. There are 3 ways the proceeds from a property development can be treated for taxation purposes: • Assessable ordinary income under section 6-5 of the ITAA 1997 as income from carrying on a business of property development; • Assessable ordinary income under section 6-5 of the ITAA 1997 as income from an isolated commercial transaction with a view to profit; or • A mere realisation of a capital asset, assessable under Parts 3-1 and 3-3 as statutory income. Section 6-10 of the ITAA 1997 states your assessable income also includes some amounts that are not ordinary income, which is assessable as statutory income.
Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3) provides guidance in determining which section of the ITAA 1997 relates to a particular transaction. Distinguishing whether profits from isolated transactions are income and assessable under section 6-5 of the ITAA 1997 or the profits are a mere realisation of a capital asset and are assessable under section 6-10 of the ITAA 1997. The relevant intention or purpose of the taxpayer (of making a profit or gain) is not the subjective intention or purpose of the taxpayer. Rather, it is the taxpayer's intention or purpose discerned from an objective consideration of the facts and circumstances of the case. Profits or gains from isolated transactions or mere realisation In Myer , at 163 CLR 213; 87 ATC 4369; 18 ATR 699-700, the Full High Court stated the following about the nature of profits from isolated transactions:
It is one thing if the decision to sell an asset is taken after its acquisition, there having been no intention or purpose at the time of acquisition of acquiring for the purpose of profitmaking by sale. Then, if the asset be not a revenue asset on other grounds, the profit made is capital because it proceeds from a mere realisation. But it is quite another thing if the decision to sell is taken by way of implementation of an intention or purpose, existing at the time of acquisition, of profit-making by sale, at least in the context of carrying on a business or carrying out a business operation or commercial transaction. It is stated in paragraph 36 of TR 92/3 that the courts have often said that a profit on the mere realisation of an investment is not income, even if the taxpayer goes about the realisation in an enterprising way. The expression 'mere realisation' is used to contradistinguish a business operation or a commercial transaction carrying out a profit-making scheme ( Myer at 163 CLR 213; 87 ATC 4368-4369; 18 ATR 699-700). The intention or purpose of the taxpayer (of making a profit or gain) referred to in Myer
is not the subjective intention or purpose of the taxpayer. Rather, it is the taxpayer's intention or purpose discerned from an objective consideration of the facts and circumstances of the case. The court stated: ..it may be said that if the circumstances are such as to give rise to the inference that the taxpayer's intention or purpose in entering into the transaction was to make a profit or gain, the profit or gain will be income... Case law - mere realisation In Casimaty v Federal Commissioner of Taxation (1997) 37 ATR 358, the taxpayer conducted a primary production business on land he owned. In order to alleviate the effects of financial hardship and deteriorating health, the taxpayer decided to sell off parts of the farm. The taxpayer developed the subdivisions only to the extent necessary to comply with conditions placed on the development consent. Over a period of 20 years the taxpayer made eight subdivisions amounting to nearly two thirds of his property.
It was held that the sales from the relevant subdivisions occurred as part of the mere realisation of a capital asset of the taxpayer. The taxpayer acquired and continued to hold the farm property for use as a residence and the conduct of a primary producer. Apart from the activities necessarily undertaken to obtain approval from time to time for subdivision of parts of the property, there was nothing to suggest a change in the purpose or object with which the property was held. Case law - mere realisation: abandonment of profit-making scheme In Rosgoe Pty Ltd v Commissioner of Taxation (2015) FCA 1231, a trustee purchased two adjacent parcels of land with the original intention to develop and sell the two properties. However, this intended plan was ultimately abandoned as funding could not be secured. The trustee subsequently rented out the two properties until they were sold several years later.
The Court held the properties were capital assets and the sale therefore resulted in capital gains, rather than being the sale of trading stock or sold as part of an isolated or commercial transaction that was entered into with a profit-making intention and resulting in ordinary income. It was held that this was due to a change of the original intention. Logan J emphasised that the intent at acquisition and later, on sale of the property should be considered separately and the transactions as distinct activities. When the property was subsequently sold, the profit arose not from the purchase but from the sale, and because the sale was not part of the profit-making scheme, the profit did not arise from the carrying on or carrying out of that scheme. Application to your circumstances In your case, your circumstances are as follows: • You purchased the property in 20XX as an investment property • You have never been in the business of land development • You had minimal involvement in the subdivision of the land
• The subdivision was a single transaction of the subdivision of an investment to build other rentals that are subsequently sold • The decision to sell the property assets was taken after the initial acquisition, there having been no intention or purpose at the time of acquisition of acquiring for the purpose of profitmaking by building on the subdivided land and sale. If a transaction or operation involves the sale of property, it is usually necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property. We consider your intention on purchasing the property was for investment purpose to derive long term rental yields. However, that intention subsequently changed due to the increase in building costs and interest rates in addition to your health issues and the decline in income. It was no longer viable for you to retain the properties and the associated loans. This intention as evidenced by the size of the proposed subdivision being only done once, the scale of the DA related activities you undertook, and you have not registered for an ABN or GST.
Therefore, the proceeds you receive from the development of your property are not ordinary income and assessable under sections 6-10 of the ITAA 1997. The proceeds represent a mere realisation of a capital asset which will fall for consideration under the CGT provisions in Part 3-1 and 3-3 of the ITAA 1997. CGT provisions A capital gain or a capital loss may arise if a capital gains tax (CGT) event happens to a CGT asset you own. Land is a CGT asset under section 108-5 of the ITAA 1997. CGT event A1 as per section 104-10 of the ITAA 1997, relating to the disposal of a CGT asset, will happen when you dispose of each subdivided block. In Taxation Determination 97/3 Income tax: capital gains: if a parcel of land acquired after 19 September 1985 is subdivided into lots ('blocks'), do Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 treat a disposal of a block of the subdivided land as the disposal of part of an asset (the original land parcel) or the disposal of an asset in its own right (the subdivided block)?
(TD 97/3), the Commissioner considers that the effect of registering separate new titles under the subdivision is, for the purposes of Parts 3-1 and 3-3 (ITAA 1997), to divide the original land parcel into two or more assets. The subdivided blocks are then treated as separate assets under the capital gains provisions. They are taken to have been acquired by the owner of the original land parcel when that original parcel was acquired. Subdividing land does not result in a CGT event if you retain ownership of the subdivided blocks. Therefore, you do not make a capital gain or a capital loss at the time of the subdivision. However, the subsequent disposal of the built rental properties constitutes a CGT event A1. As a post-CGT asset, the CGT on the sale of the properties will not be disregarded. In your case, you acquired the property in 20YY, the property is a post-CGT asset. Subsection 104-10(4) of the ITAA 1997 provides that a capital gain will arise if the capital proceeds from the disposal are more than the asset's cost base and a capital loss will arise if the capital proceeds are less than the asset's reduced cost base.
Additionally, when a property owner enters into an arrangement to develop and sell their land and dwelling, the key question to be determined is whether the ultimate sale is a 'mere realisation' or is it a disposal either in the course of business or as part of a profit-making undertaking or plan. A 'mere realisation' is a sale on capital account to which the CGT rules will generally apply. Landholders will usually seek this treatment if they can access the CGT concessions, or the property is a pre-CGT asset. A sale that is more than a 'mere realisation' will be on revenue account and proceeds will generally be assessable as income. The two common scenarios where the proceeds are income are: • Where the land is sold in the course of a business or as an incident of the business operations; or • Where the land has been acquired and sold as part of a profit-making undertaking or scheme.
Whether a sale is a 'mere realisation', or something more, is determined by examining and weighing all the facts and circumstances taken as a whole. The next section outlines some relevant facts which must be considered, and how they might be relevant to determining the answer to the question. The intention of the landowner must be judged objectively from the facts and evidence, and not from the landowner's stated intention. Consideration if there has been any change in intention from the initial purchase of the land or asset. Indications for determining whether a sale of developed land is more a 'mere realisation' The initial purpose was to use the subdivision of land and sale of a portion as a profit-making venture. The initial intention was to acquire the property as an investment and derive rental income, this usually indicates an asset on a capital account. Mere realisation confirmed with an exit strategy including profitable resale by development or sale to a developer.
Consider the dates for the council request for rezoning in respect to the purchase of the initial investment property and the reason provided for the subdivision. The sooner the request to subdivision the more this indicates that the property was acquired with the intention of development even when it was initially rented. Other considerations are the initial purchase location being near the urban fringe of a major city, the size of the initial property. When the landowner actively sought rezoning is considered an engagement of profit making while if the rezoning could be done without any action, this is mere realisation. History of the land/property owners in the subdivision of land for resale. A strong indicator for mere realisation is if the sale is done on a small scale and or this is the first subdivision transaction one by the taxpayer. In your case, the initial intention was to subdivide and build more rental properties as investments. This is evidenced by the: • finance obtained from financial institutions to purchase the dwelling as an investment loan. • properties were rented out on completion of their building.
• land originally purchased for rental income as a post -CGT asset. The land was zoned as a residential property with a dwelling when it was first acquired. • The timeline outlines the rezoning / subdivision since it was purchased, the reason for the subdivision was for return on the investment and the rezoning occurred after seeking advice from financial advisors. This is not a sale of land in the course of a business, incident of business operation nor is it land that has been acquired and sold as a profit-making operation, therefore not more than mere realisation. CGT event A1 in section 104-10 of the ITAA 1997, relating to the disposal of a CGT asset, will happen when you dispose of each subdivided block. Subsection 104-10(4) of the ITAA 1997 provides that a capital gain will arise if the capital proceeds from the disposal are more than the asset's cost base and a capital loss will arise if the capital proceeds are less than the asset's reduced cost base. Furthermore, from not only considering subdivision as the mere realising of property on capital account and the sale is treated as a capital gain, 50% CGT discount will apply.
Carrying on a business Taxation Ruling 97/11 Income tax: am I carrying on a business of primary production? (TR 97/11) provides the Commissioners view on whether a taxpayer is carrying on a business. same principles can be applied to the question of whether a taxpayer is carrying on any type of business including property subdivision and development. Paragraph 18 outlines that some of the indicators are relevant: • Whether the activity has a significant commercial purpose or character. • Whether the taxpayer has more than just an intention to engage in business. • Whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity. • Whether there is repetition and regularity of the activity. • Whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business. • Whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit. • The size, scale and permanency of the activity.
Section 995-1 of the ITAA 1997 states that the term 'business' includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee. Application to your circumstances In this case: • The transactions are on a commercial purpose of making profit as rental properties initially. • The taxpayer had one intention - as a rental property investment and not the sub-division and sale of the property. • There is no repetition and regularity of the activity as indicated in the application. The subdivision has only occurred once, and the taxpayer has said they has not done a transaction such as this before. • The activities can be said to be operated in a businesslike manner - planned, sort advice from appraisers and finance brokers. • You are both working as employees. These are outside the scope of your normal work. You are not carrying on a business of the sub-division of land and the sale of the separate lots. Conclusion
Taking all of the facts into consideration, and on weighing the various factors, the Commissioner considers the activity is a mere realisation. The subdivision of the Land and the sale of the subdivided lots would be the mere realisation of an asset: it is the disposal of a CGT asset that is subject to capital gains tax. Upon the execution of the sale contract CGT event A1 will happen in relation to each lot. In this case, CGT event A1 (section 104-10 of the ITAA 1997) only happens when the taxpayer sells a subdivided lot to another entity. The time of the event is when they enter into the contract for disposal. If there is no contract, the CGT event happens when they stop being the owners of the subdivided lot. The taxpayer will make a capital gain from each subdivided lot if the capital proceeds from the disposal are more than the relevant cost base of each subdivided lot.
Therefore, the proceeds you received from the sale of the property are not ordinary income and not assessable under sections 6-5 or 15-15 of the ITAA 1997. The proceeds represent a mere realisation of a capital asset which will fall for consideration under the CGT provisions in Part 3-1 and 3-3 of the ITAA 1997.